DETERMINANTS OF CURRENT ACCOUNT BALANCE OF ETHIOPIA ECONOMY

Abstract

The purpose of this paper is to investigate the empirical linkage between current account balance of Ethiopia and macroeconomic variables based on the inter-temporal approach using recent econometric techniques from 1980 to 2015. Auto Regressive Distributed Lagged Model adopted to investigate the existence of short run and long run relationship between current account balance and set of macroeconomic variables. The model based on inter-temporal approach to current account considers current account as an inter-temporal phenomenon given that; it is the difference between domestic saving and investment. The result of the econometric analysis indicated that there is a long run relationship between current account balance and fiscal balance, real effective exchange rate, terms of trade, and Real GDP growth and statistically significant. Variable such as foreign direct investment, age dependency, financial deepening, trade openness and relative income found statistically insignificant in the long run. Among policy implication that comes out of this study is that large amount of government spending is needed in order to expand infrastructures which are supposed to increase private investment particularly for those participate in manufacturing and export sectors. In addition, devaluation of domestic currency that improves current account balance is appropriate but government should be careful in taking such measurement since it increases the cost of imported inputs and inflationary pressure on domestic price.